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Insurers' woes could hit muni bond ratings

Mortgage losses may affect some firms' ability to pay claims.

December 22, 2007|Tom Petruno | Times Staff Writer

The financial troubles of major bond insurers are rattling the municipal bond market, where about half the bonds issued in recent years have carried private insurance -- including in California.

If you own muni bonds, it might be wise to take a closer look at your portfolio to see how it could be affected by the insurers' woes. But there's a very good chance the bonds you hold didn't really need insurance in the first place, analysts say.

Many states and municipalities have long used private insurance as a way to enhance the appeal of their tax-free securities for investors -- turning, say, an A-rated bond into a AAA-rated one.

Now, Wall Street is worried about the health of the insurers that backed those gilded ratings because of the potential claims the companies face from insuring other bonds, particularly mortgage-backed securities.

"Their ability to meet their claims-paying obligations is being called into question," said Jon Schotz, co-founder of Saybrook Capital, a Santa Monica-based investment fund that focuses on muni bonds.

On Wednesday, credit-rating firm Standard & Poor's slashed the rating of bond insurer ACA Financial Guaranty Corp. to CCC from A, citing the company's exposure to mortgage-bond losses.

ACA is a relatively small bond insurer. But the industry's giants, such as MBIA Inc. and Ambac Financial Group Inc., also are facing more scrutiny. If their ratings are cut, the ratings of some of the muni bonds they insure also would drop.

Fitch Ratings on Thursday placed 173,000 muni bonds guaranteed by MBIA on "watch" for possible downgrades unless the company can raise more capital or buy backup insurance from other carriers to underpin its coverage.

When a bond is downgraded, its market value may drop, although the rating change wouldn't affect the interest payments the bond issuer makes to investors.

Many analysts caution against overstating the risk to muni securities from the insurers' problems.

For one, most of the bonds backed by insurance firms would have investment-grade ratings even without the insurance, said Howard Mischel, an analyst at Standard & Poor's in New York.

"Usually, A-rated bonds and above" are what the insurers have been willing to cover, he said.

What's more, regardless of their ratings, muni bonds historically have been among the least likely fixed-income securities to face default. States and municipalities almost always find ways to pay what they owe bondholders, even in times of fiscal stress.

Even if muni issues are downgraded because of insurance companies' problems, "Most of these bonds are going to be 'money good,' " said Bob Gore, a veteran muni bond trader at brokerage Crowell, Weedon & Co. in Los Angeles.

Then why have states and municipalities bothered with insurance in the first place?

The insurance premium they're charged typically is offset by a small savings on the interest rate they pay on their bonds. For example, investors might accept a yield of 4.25% a year on an insured bond, compared with 4.35% on an uninsured issue.

Also, the use of insurance has made it easier for muni borrowers to sell bonds in large quantities to institutional investors who don't have to do as much homework in evaluating insured securities compared with uninsured securities, analysts say.

But in recent weeks, as worries have mounted about the insurers' health, some muni issuers have stopped buying insurance altogether. California sold $1 billion in general obligation bonds in late November. The state usually buys insurance on some parts of its bond deals, but opted to forgo that backing on the latest offering.

Worries about the insurance firms' finances "raise too many questions about the value of the insurance," said Tom Dresslar, a spokesman for state Treasurer Bill Lockyer.

For individual investors who own muni bonds, "It's a good time to review your portfolio," Gore said.

Investors who bought insured issues should check the underlying rating of each bond, Gore said -- in other words, if the insurance wasn't there, would the bond still be investment grade? Or would it be below investment grade, putting it in "junk" territory?

Even in cases in which a muni bond's rating is cut, if the issuer remains financially sound and you can hold the bond until it matures, you'll continue collecting interest as promised and you'll be paid off in full when the bond's term is up.

The risk would be if you have to sell the bond before it matures. The lower a bond's credit rating, the lower the price you're likely to get in the market.

tom.petruno@latimes.com

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